Rush Enterprises – Buy In For The Long Haul?

Rush Enterprises, Inc. (NASDAQ:RUSHA) is a retailer of commercial vehicles and related services. The company operates a regional network of commercial vehicle dealerships under the name Rush Truck Centers. The company, through its Rush Truck Centers, offers services, including retail sales of new and used commercial vehicles, aftermarket parts sales, service and repair facilities, financing, leasing and rental, and insurance products. Rush Truck Centers primarily sell commercial vehicles manufactured by Peterbilt, International, Hino, Ford, Isuzu, Mitsubishi Fuso, IC Bus or Blue Bird. At its Rush Truck Centers, the company offers third party financing to assist customers in purchasing new and used commercial vehicles.

Although 67% of total revenues come from Truck Sales, it only makes up 28% of gross profits. Conversely, Parts and Services is 28% of total revenues but 64% of gross profits. The Parts and Services segment is the most important part of the business.

Retail Truck Sales and Servicing Markets

Rush sells several different types of trucks. The heaviest trucks are class 8 trucks. Medium grade trucks are classified as class 4-7. The company also sells used trucks. Rush has a fair amount of exposure to the oil and gas industry through its sales of class 8 trucks. The dip in the price of oil over the last 18 months has negatively affected their business. However, the company has significantly diversified its sales by entering into the construction industry over the last ten years. This move has helped insulate their truck sales during the recent downturn in the price of oil.

Rush uses A.C.T Research Co. LLC, a truck industry data and forecasting service provider to help them forecast truck sales. According to A.C.T Research, U.S. Class 8 retail sales are estimated to total 222,000 units in 2016, a 12.2% decrease compared to 253,000 units in 2015. This slowdown in sales is related to the slowdown in the oil and gas industry. Below is the historical class 8 retail sales.

The decline in class 8 sales might be scaring off investors. However, looking back at previous cycles, Rush has noted that slowdowns in truck sales translate into pent up demand. The graph above is a perfect example of this phenomenon. The slowdown from ’07-’10 created pent up demand that has been working off over the last five years. The slowdown in the oil and gas industry might cause these companies to put off replacing trucks but they will inevitably be replaced.

Parts and Service

The most important piece of the business is the servicing of trucks previously sold. Parts and Service is high margin recurring revenue. Blended gross margins on aftermarket services operations are expected to range from 36.5% to 37.0% in 2016. Rush Enterprises expects the parts and services to grow at mid single digits in 2016. The company is focused on growing this part of the business. The reason they sell trucks is so they can service them later. Current growth initiatives include expansion of product and service offerings that complement their primary product lines.

Telematics

Rush is taking advantage of technological advances to have the ability to service vehicles while they are out on the road. This is accomplished by using telematics. Trucks will now receive software updates without having to take up a servicing bay. This will provide space for additional trucks needing service. Gross margins on service and body shop operations historically have ranged from 67% to 68%. Having additional bays available increases the total number of trucks being serviced along with trucks receiving service and body shop operations. This high margin business could boost the blended gross margins on aftermarket service operations well above the current 37%.

Absorption Ratio

The company tracks the ratio of gross profit from the parts, service and body shop departments of a dealership to the overhead expenses of all of a dealership’s departments. This is just another way of showing operating leverage. They have done very well and with their long-term growth strategies I would think they will continue to increase this ratio.

Competitive Advantages

A significant portion of the new commercial vehicle sales are to fleet customers. Because of the size and geographic scope of the Rush Truck Center network, their strong relationships with fleet customers and ability to handle large quantities of used commercial vehicle trade-ins, they are able to successfully market and sell to fleet 9 customers nationwide. The company believes they have a competitive advantage over most other dealers in that they can absorb multi-unit trade-ins often associated with fleet sales and effectively disperse the used commercial vehicles for resale throughout the dealership network. The broad range of services offered to purchasers of commercial vehicles at the time of purchase and post-purchase has resulted in a high level of customer loyalty.

Pricing is an important element of Rush’s marketing strategy. Because of their size, they benefit from volume purchases at favorable prices that permit them to achieve a competitive pricing advantage in the industry. Historically, the company has been able to negotiate favorable pricing and terms, which enables them to offer competitive prices for their trucks.

Dealership Agreements

Rush has non-exclusive dealership agreements with Peterbilt, International, BlueBird, Ford, Hino, Isuzu, Micro Bird and Mitsubishi Fuso. The two largest agreements are with Peterbilt and International. These two dealers account for half of the total revenues of the company. The dealerships compete with dealerships representing other manufacturers including commercial vehicles manufactured by Mack, Freightliner, Kenworth, Volvo, and Western Star. Peterbilt (owned by PACCAR) and International produce quality trucks that have customer loyalty. These agreements with companies possessing brand loyalty helps Rush in selling trucks. However, this is a double edged sword. If these manufactures are less successful in the future, this could have a direct impact on Rush.

Industry Outlook

The U.S. retail truck market is affected by a number of factors relating to general economic conditions. The business is subject to substantial cyclical variation based on general economic conditions. However, infrastructure in the U.S. is aging and there will need to be a massive amount of construction spending over the next 20 years to repair or replace aging infrastructure. The construction market is expected to be one of the fastest growing markets over the next five years with a 5.2% CAGR.

Long Runway For Growth

Rush has about 100 truck centers across the U.S in 21 states. There is plenty of room for growth. See the screenshot below of current Rush Truck Centers.

There are several large markets where Rush has no exposure today. The following information comes from the U.S Federal Highway Administration and the U.S Bureau of Transportation Statistics.

Looking at this, I think the only areas where Rush has good exposure is Southern CA, Texas, and Florida/Georgia. The company has significant growth opportunities in Northern CA, the Northwest, Northeast, Midwest, and South. Rush has no exposure to the Northeast and the Northwest. These regions have terrific potential. Refer below to see the DOT’s prediction of truck routes in 2040.

There is going to be a lot of growth in major truck routes over the next 25 years. A lot of this growth will be in the Midwest region where Rush has a fair amount of truck centers. It looks like there will be opportunity to open quite a few more. Northern CA and the Northeast will also experience significant growth. Rush will have an opportunity to enter these markets.

Risks

There are several risks to the business that are worth addressing. 1) Slowdown in economic conditions. A general slowdown in the economy would not be good for Rush. Customers will continue to have their trucks serviced but sales could drop which would be bad for the stock. 2) Rush is dependent on PACCAR and Navistar for the supply of quality trucks and parts. Together, these two companies account for about 50% of total revenues. Rush needs PACCAR and Navistar to be successful in producing the best trucks on the road. Failure to renew an agreement with either PACCAR or Navistar could cause volatility in the stock price. 3) Peterbilt may terminate dealership agreements in the event of a change of control of the company. There are eleven individuals with Rush that are deemed the Dealer Principals. Collectively they have 30.33% of the voting rights. If the aggregated control drops below 22%, Peterbilt is allowed to terminate its agreement. It is unknown if Peterbilt would exercise their right in this circumstance but it is worth noting.

Financial Overview

Rush will need margin expansion in the next few years. With technological advancements and opening new service centers, there should be opportunities to grow margins. The servicing of trucks is where the company makes its money.

Leverage

The balance sheet indicates the company has a fair amount of leverage. The company has maintained about the same amount of leverage over the last five years as it has grown. The business is capital intensive so this isn’t a big surprise. I will be keeping an eye on their debt situation as I don’t want to see them become more levered, 1.8x is enough. However, the terms of the debt are favorable and they are not exposed to a potential rising interest rate environment in the U.S. Most of their debt is fixed and the variable portion is tied to LIBOR.

Valuation

The stock is down about 25% since last October due to the price of oil. I think the valuation is reasonable. The business is still small and has potential to grow. However, considering current profitability, I don’t know how they can grow without taking on more debt. This puts the company in a tough place considering the current valuation.

Bottom Line

Rush is an interesting business. As the business grows to sell more trucks it will also service more which is the most important part of the business. I would really be interested to know what percentage of trucks sold by Rush are serviced by them. Unfortunately, they don’t disclose this information. Going forward, I would like to see the business focus on current operations and becoming more profitable. However, the company’s strategy is to continue to expand and steal market share. I am not sure how they can do this without taking on more debt. I think the valuation is reasonable but I worry about the debt situation. The trucking industry is set to grow a lot over the next 25 years. I think Rush will be a part of it. If the balance sheet improves and the valuation remains stable, I think it would be an interesting company to own.